EXCLUSIVE-Saudi Arabia preparing tougher rules for insurers - sources

* Aims to halve number of insurers in the kingdom - sources (Adds background, analyst quotes)

RIYADH/DUBAI, Oct 11 (Reuters) - Saudi Arabia's central bank is preparing tougher rules for insurance companies as part of a drive to create a smaller number of stronger market players operating in the country, two people with direct knowledge of the matter told Reuters.

A new supervisory framework will be introduced in the coming months that will force insurers to boost capital significantly as well as improve internal risk controls, said the sources, who declined to be named due to the sensitivity of the matter.

The moves are aimed at triggering consolidation in the insurance industry and forcing weaker companies to merge with stronger ones, industry analysts said.

"They (central bank officials) said half of the companies that are here today will not be here," one of the sources said. "They want stronger companies in the market."

The proposed changes were discussed during a meeting between officials of the Saudi Arabia Monetary Authority (SAMA) and senior insurance executives this week, the people said.

SAMA did not immediately respond to a Reuters request for comment.

Current requirements for companies to have at least 100 million Saudi riyals ($27 million) of capital for insurance activities in Saudi Arabia, or 200 million for reinsurance activities, are likely to be significantly increased, the sources said.

The Saudi insurance sector has come under pressure as the economy has slipped into recession this year, with health insurance suffering in particular as expatriates have left the kingdom and hospital costs have risen, the sources said.

ABRUPT LIBERALISATION

That pressure has exacerbated problems stemming from the sector's abrupt liberalisation a decade ago, when the central bank licensed some 30 insurance firms in an attempt to encourage the sector and cut the economy's reliance on oil.

Ten of the companies licensed at that time are now unprofitable. Mediterranean and Gulf Cooperative Insurance and Reinsurance Co (MedGulf), one of the most troubled, posted accumulated losses in the second quarter that surpassed 73 percent of its capital.

Over the last year, 11 firms have been temporarily suspended from issuing new insurance policies, some more than once.

Among them was Sharia-compliant insurer SABB Takaful , which earlier this month was stopped from issuing or renewing insurance or savings products.

The biggest Saudi insurance companies by assets, Company for Cooperative Insurance and Bupa Arabia for Cooperative Insurance Co, are not among those facing problems.

Saudi Arabia's insurance market is fragmented, with only a few companies dominating the sector and an abundance of smaller firms unable to make inroads.

Excluding the top five insurers, market share for the remaining 29 firms is below 37 percent, said Mohammed Ali Londe, a Dubai-based credit analyst at Moody's Investors Service. The figure drops under 24 percent when excluding the top 10 insurers in the market, he said.

SCRAMBLING TO COMPETE

That has left smaller companies scrambling to compete on prices amid limited appetite for their products, with insurance penetration in Saudi Arabia among the lowest in the region and globally at 1.5 percent of GDP.

SAMA's solution is to engineer mergers among these smaller companies or acquisitions by larger and healthier ones, although it is difficult to force companies into this, the sources said.

"Their hope is that if the companies merge, there will be more economies of scale and so on," said the source, adding: "But if you put two bad apples together, you may just end up with one even bigger bad apple,"

The central bank is wary of letting the companies fail, the sources said, as more than half of the shares are owned by politically sensitive retail investors in a market unaccustomed to liquidations.

The capital position of companies has improved due to rights issues, however there are still a handful of companies that need to significantly improve their solvency, S&P Global Ratings' London-based analyst David Anthony told Reuters.

"In these cases, it is hard not to believe that regulators will be extremely keen to see the ailing insurer acquired by a stronger institution, whether domestic or foreign," Anthony said.